The EM trends that matter

Many investors have historically been hesitant to invest in emerging markets, concerned about currency volatility, political instability and an over-reliance on commodities. Yet this view is increasingly outdated as the sector evolves and becomes more resilient.

Digital transformation

A large proportion of emerging market populations now access the Internet principally via smartphones. This is spurring phenomenal innovation and driving huge growth in e-commerce. The success of Chinese companies Alibaba and Tencent in building digital ecosystems that include everything from e-finance, e-commerce, to online-to-offline services and mobile gaming is well documented.

But China is not alone. In fact, India currently provides one of the most powerful examples of how digital transformation is taking hold. Mobile penetration is still low, but the number of smartphone users is increasing dramatically and forecast to expand to more than 440 million by 2022 (from 199 million in 2015). A total of 70% of the population accesses the internet exclusively through mobile devices, enabling a broader slice of the population to get connected (two-thirds of the population live in rural areas).¹

More importantly, mobile connectivity now means a whole layer of financial inclusion can open up. There are now more than 300 million Aadhar-linked bank accounts and the next technology step could see users able to carry out transactions through biometric authentication on their smartphone or tablets, with no need for cash or even cards.²

Financial institutions in many emerging markets have been quick to embrace technology, making them world leaders in the use of electronic distribution channels.

¹ Statista, DMO, We Are Social survey January 2017, comScore MMX Multi-Platform as at May 2017.

² Unique Identification Authority of India, Government of India

Global innovators

Emerging markets are rapidly becoming synonymous with innovation. Strong technical education, state support and growing internet penetration, have all driven a surge in creativity.

This is evident when looking at intellectual property generation, as measured by patents, trademarks and industrial designs. According to the World Intellectual Property Organisation, half of all international patent (Patent Cooperation Treaty – PCT) applications now originate in East Asia – with China having rocketed to second place globally (after the US) last year. Indeed, the two companies with the largest number of applications globally are Chinese telecom firms Huawei and ZTE.

The reform dividend

We believe momentum from reform is key to the compelling structural growth story in emerging markets. So, when countries act to reduce trade barriers, improve capital flows, developing infrastructure or enhance institutional frameworks this is a vital driver of long-term economic and social change.

India is a good case study. Since assuming office in 2014, Indian Prime Minister Narendra Modi’s government has put in place many reforms aimed at strengthening the nation’s infrastructure and economic fundamentals.

Notably, Foreign Direct Investment (FDI) conditions have been reduced or eliminated in a wide range of sectors including defence, real estate, civil aviation and construction. As a result, India experienced record inflows from foreign investors in 2017 and once again featured in the list of top host countries for inbound FDI in 2017, receiving an estimated US$45 billion in investment during the year.¹

The best example of the ambition of India’s reform programme is Aadhar – the largest biometric ID database in the world – which aims to give every one of its citizens an official, verifiable identity. It is the only non-US and non-Chinese based technical system in the world that has more than one billion users.

Intra EM trade

In contrast to growing protectionist policy measures in many developed economies, EM countries are actively cultivating and developing their trade partnerships.

As the chart below illustrates most international trade is now between advanced and emerging economies, unlike twenty years ago when the majority of international trade took place between advanced economies. Significantly, it is exports between emerging economies that has increased the most. China, for example, is by far the top export destination for Brazilian products. While the number one exporter to South Africa, India and Russia is China. This intra-regional trade is only set to continue with trade blocs, such as the ASEAN Free Trade Area (which includes Thailand, Vietnam, Indonesia, Malaysia, Philippines, Singapore, Myanmar, Cambodia, and Laos) generating considerable internal trade momentum outside trading links with developed markets.

The changing sources of global trade

Source Martin Currie and Statista. Statista sources: IWF, WB, WTO.

Conclusion

The developments outlined above are radically changing the sort of stocks an investor might expect to see in emerging markets. Information technology stocks at 28.65% now make up the biggest sector weight in the MSCI Emerging Markets Index, with financials at 23% being the second biggest weight and consumer discretionary at 9.39% third largest. By contrast as recently as 2008, the composition of the index was dominated by energy, materials and financials.

As such, we are confident that the economies and corporates in emerging markets offer exciting, selective opportunities. The quantity and quality of information in emerging markets can be quite different from that of developed markets, so we believe actively selecting stocks is more effective than passively tracking the index.

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IMPORTANT INFORMATION: All investments involve risk, including loss of principal. Past performance is no guarantee of future results. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice. Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

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